The Federal Reserve Board gave the bond market an appropriate gift on Thanksgiving eve by lowering the discount rate from 9 percent to 8 1/2 percent. The discount rate is the interest rate the Fed charges members of the banking system when they borrow from the Fed. Although this is a lagging rate in the sense that if it follows the direction of other short-term interest rates, the significance of the cut is that it validates, or confirms, the declines that have already occurred. And it removes from everyone's mind, just in case there are any doubters, that the Fed has eased, and that the Fed wants interest rates lower to stimulate growth of the basic monetary aggregate -- M1 -- and with it, the economy, whose growth had fallen to 1.9 percent during the third quarter of the year.
As we have said before, the United States and the world cannot afford another economic recession, and the Fed is making an overt effort to ease monetary conditions and lower interest rates to avoid a recession. Interestingly enough, interest rates have fallen almost to the levels that ignited the business recovery that began in late 1983 -- and through the first half of 1984.
As Bob Giordano, an economist at Goldman Sachs points out, it is curious that we seem to have a dichotomous economy. The service sector is booming with employment surging and wages up. However, the manufacturing side of the economy is being devastated by foreign competition and a strong dollar. Although our exports have been growing, the strength of the dollar has made our products more expensive and therefore less desirable to foreigners. On the import side, the strong U.S. dollar has made foreign products less expensive in dollar terms and therefore more desirable. At the same time, as we have accelerated the importation of cheaper foreign products, the U.S. industries that compete against these imports have been badly hurt. All of this has given rise to our estimated record setting merchandise trade deficit of around $130 billion for 1984.
Giordano also points out that, in the spring, it was necessary to keep the dollar strong, which necessitated keeping rates high. Now, it is necessary to keep interest rates low to prevent the dollar from strengthening further. Obviously, the Fed realizes the consequences of a strengthening dollar -- it could lead to a recession -- and is attempting to push rates lower also to relieve upward pressure on the dollar.
For holders of fixed-income securities, this means that interest rates will move still lower. It also means that rates on money market funds will continue to decline, although more slowly than market rates. Conversely, when rates begin to rise again, the rates on the money market funds will lag the increase in the market rates. It would therefore be prudent for investors who are especially concerned about income, and who can afford to leave their money in an investment for a period of time, to consider quickly moving funds from their money market funds into non-negotiable bank and thrift certificates of deposit before those rates are lowered. Currently, they are returning 10.50 percent from 12 months to 24 months and 11.00 percent from 24 months to 36 months. Rates, maturities and terms vary widely at different financial institutions, so shop around.
The Treasury will offer a 5-year, 2-month note in minimums of $1,000 on Wednesday. They should return about 10.85 percent.